PART I. Financial Information

 

Item 1. Financial Statements

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Balance Sheets

(Dollars in thousands, except per share data)

 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Statements of Income

(Unaudited)

(Dollars in thousands, except per share data)

 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Consolidated Statements of Cash Flows 

(Unaudited)

(Dollars in thousands)

 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

 

NATURAL GROCERS BY VITAMIN COTTAGE, INC.

 

Notes to Unaudited Interim Consolidated Financial Statements

 

December 31, 2017 and 2016

 

 

 

 

 

 

 

 

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our unaudited consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and with the audited consolidated financial statements and notes thereto in our Form 10-K. This MD&A contains forward-looking statements. Refer to “Forward-Looking Statements” at the beginning of this Form 10-Q for an explanation of these types of statements. Summarized numbers included in this section, and corresponding percentage or basis point changes, may not sum due to the effects of rounding.

 

Company Overview 

 

We operate natural and organic grocery and dietary supplement stores that are focused on providing high quality products at affordable prices, exceptional customer service, nutrition education and community outreach. We offer a variety of natural and organic groceries and dietary supplements that meet our strict quality standards. We believe we have been at the forefront of the natural and organic foods movement since our founding. We are headquartered in Lakewood, Colorado. As of December 31, 2017, we operated 142 stores in 19 states, including Colorado, Arkansas, Arizona, Idaho, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington and Wyoming. We also operate a bulk food repackaging facility and distribution center in Golden, Colorado.

 

We offer a variety of natural and organic groceries and dietary supplements that meet our strict quality guidelines. The size of our stores varies from 5,000 to 16,000 selling square feet. During the twelve months ended December 31, 2017, our new stores averaged approximately 11,000 selling square feet. Our new prototype store has approximately 10,000 square feet of selling space. We anticipate that in the future, a majority of our new stores will use the new prototype layout.

 

The growth in the organic and natural foods industry and growing consumer interest in health and nutrition have enabled us to continue to open new stores and enter new markets. During the five fiscal years ended September 30, 2017, we increased our store count at a compound annual growth rate of 18.9%. In fiscal year 2017, we opened 14 new stores, and we currently plan to open eight to 10 new stores in fiscal year 2018, two of which opened during the three months ended December 31, 2017. Since December 31, 2017, we have opened one new store in Texas. As of the date of this report, we have signed leases for 10 new stores that we plan to open in fiscal years 2018 and beyond. During fiscal year 2018, we plan to relocate three to four stores. During the quarter ended December 31, 2017, we relocated one store.

 

Performance Highlights

 

Key highlights of our performance for the three months ended December 31, 2017 are discussed briefly below and in further detail throughout this MD&A. Key financial metrics, including, but not limited to, comparable store sales, daily average comparable store sales, mature store sales and daily average mature store sales are defined under the caption “Key Financial Metrics in Our Business,” presented later in this MD&A.

 

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Net sales. Net sales were $202.5 million for the three months ended December 31, 2017, an increase of $18.9 million, or 10.3%, compared to net sales of $183.6 million for the three months ended December 31, 2016.

 

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Comparable store sales and daily average comparable store sales. Comparable store sales and daily average comparable store sales for the three months ended December 31, 2017 each increased 4.7% compared to the three months ended December 31, 2016.

 

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Mature store sales and daily average mature store sales. Mature store sales and daily average mature store sales for the three months ended December 31, 2017 each increased 1.6% compared to the three months ended December 31, 2016.

 

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Net income. Net income was $5.2 million for the three months ended December 31, 2017, an increase of $3.1 million, or 151.4% compared to net income of $2.1 million for the three months ended December 31, 2016. Net income was favorably impacted by $4.3 million due to the non-cash remeasurement of deferred tax assets and liabilities.

 

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EBITDA. Earnings before interest, taxes, depreciation and amortization (EBITDA) was $9.6 million for the three months ended December 31, 2017, a decrease of $1.7 million, or 14.9%, from $11.3 million for the three months ended December 31, 2016. EBITDA is not a measure of financial performance under GAAP. Refer to the “Non-GAAP Financial Measures” section in this MD&A for a definition of EBITDA and a reconciliation of net income to EBITDA.

 

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Liquidity. As of December 31, 2017, cash and cash equivalents was $8.1 million, and there was $24.4 million available for borrowing under our $50.0 million Credit Facility, net of undrawn, issued and outstanding letters of credit of $1.0 million.

 

 

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New store growth. We opened two new stores during the three months ended December 31, 2017. We operated a total of 142 stores as of December 31, 2017. We plan to open a total of eight to 10 new stores in fiscal year 2018, which would result in an annual new store growth rate of 5.7% to 7.1% for fiscal year 2018.

 

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Store Relocations and Remodels. During fiscal year 2018, we plan to relocate three to four stores. During the quarter ended December 31, 2017, we relocated one store.

 

Industry Trends and Economics

 

We have identified the following recent trends and factors that have impacted and may continue to impact our results of operations and financial condition: 

 

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Impact of broader economic trends. The grocery industry and our sales are affected by general economic conditions, including, but not limited to, consumer spending, the level of disposable consumer income, consumer debt, interest rates, the price of commodities, the political environment and consumer confidence. In this regard, we believe our financial results for the three months ended December 31, 2017 reflected improvement in the oil and gas markets we serve, although they generally continue to lag behind our non-oil and gas markets.

 

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Opportunities in the growing natural and organic grocery and dietary supplements industry. Our industry, which includes organic and natural foods and dietary supplements, continues to experience growth driven primarily by increased public interest in health and nutrition. Capitalizing on this opportunity, we continue to open new stores and enter new markets. As we open new stores, our results of operations have been and may continue to be materially adversely affected based on the timing and number of new stores we open, their initial sales and new lease costs. The length of time it takes for a new store to become profitable can vary depending on a number of factors, including location, competition, a new market versus an existing market, the strength of store management and general economic conditions. Once a new store is open, it typically grows at a faster rate than mature stores for several years. Mature stores are stores that have been open for any part of five fiscal years or longer.

 

As we expand across the United States and enter markets where consumers may not be as familiar with our brand, we seek to secure prime real estate locations for our stores to establish greater visibility with consumers in those markets. This strategy has resulted in higher lease costs, and we anticipate these increased costs will continue for the foreseeable future. Our financial results for the three months ended December 31, 2017 reflect the effects of these factors, and we anticipate future periods will be similarly impacted.

 

Our performance is also impacted by trends regarding natural and organic products, dietary supplements and at-home meal preparation. Consumer preferences towards dietary supplements or natural and organic food products might shift as a result of, among other things, economic conditions, food safety perceptions, changing consumer choices and the cost of these products. A change in consumer preferences away from our offerings, including those resulting from reductions or changes in our offerings, would have a material adverse effect on our business. Additionally, negative publicity regarding the safety of dietary supplements, product recalls or new or upgraded regulatory standards may adversely affect demand for the products we sell and could result in lower consumer traffic, sales and results of operations.  

 

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Increased Competition. The grocery and dietary supplement retail business is a large, fragmented and highly competitive industry, with few barriers to entry. Our competition varies by market and includes conventional supermarkets such as Kroger and Safeway, mass or discount retailers such as Wal-Mart and Target, natural and gourmet markets such as Whole Foods and The Fresh Market, foreign-based discount retailers such as Aldi and Lidl, specialty food retailers such as Sprouts and Trader Joe’s, warehouse clubs such as Sam’s Club and Costco, independent health food stores, dietary supplement retailers, drug stores, farmers’ markets, food co-ops, online retailers such as Amazon, meal delivery services and multi-level marketers. Competition in the grocery industry is likely to intensify, and shopping dynamics may shift, as a result of, among other things, Amazon’s acquisition of Whole Foods in August 2017, the plans of Aldi and Lidl to expand their presence in the United States and the expanding availability of grocery ordering, pick-up and delivery options. These businesses compete with us on the basis of price, selection, quality, customer service, shopping experience, ease of ordering and delivery or any combination of these or other factors. They also compete with us for products and locations. In addition, some of our competitors are expanding to offer a greater range of natural and organic foods. We believe our commitment to carrying only carefully vetted, affordably priced and high-quality natural and organic products and dietary supplements, as well as our focus on providing nutritional education, differentiate us in the industry and provide a competitive advantage. In addition, we face internally generated competition when we open new stores in markets we already serve.

 

 

Outlook

 

We believe there are several key factors that have contributed to our success and will enable us to increase our comparable store sales and continue to expand profitably. These factors include a loyal customer base, increasing transaction count and/or basket size, growing consumer interest in nutrition and wellness, a differentiated shopping experience that focuses on customer service, nutrition education and a shopper friendly retail environment, and our focus on high quality, affordable natural and organic groceries and dietary supplements.

 

We plan for the foreseeable future to continue opening new stores and entering new markets. The rate of new store growth in the foreseeable future is expected to moderate somewhat compared to recent years, depending on economic and business conditions and other factors. During the past few years, we have expanded our infrastructure to enable us to support our continued unit growth. This has included implementing our enterprise resource planning system, hiring key personnel, developing efficient new store opening construction and operations processes and relocating and expanding our bulk food repackaging facility and distribution center. In addition, we have taken a number of actions in recent years which we believe have enhanced customer loyalty and increased customer engagement, including redesigning our website (www.naturalgrocers.com), enhancing digital and social media presence, and introducing the {N}power^® customer appreciation program at all of our stores.

 

We believe there are opportunities for us to continue to expand our store base, expand profitability and increase comparable store sales. However, future sales growth, including comparable store sales, and our profitability could vary due to increasing competitive conditions in the natural and organic grocery and dietary supplement industry and regional and general economic conditions. As we continue to expand our store base, we believe there are opportunities for increased leverage in costs, such as administrative expenses, as well as increased economies of scale in sourcing products. However, due to our commitment to providing high-quality products at affordable prices and increased competition, such sourcing economies and efficiencies at our bulk food repacking facility and distribution center may not be reflected in our gross margin in the near term. In addition, our ability to leverage costs may be limited due to the fixed nature of our rent obligations and related occupancy expenses.

 

Our operating results may be affected by the above-described factors as well as a variety of other internal and external factors and trends described more fully in Item 1A - “Risk Factors” in our Form 10-K and Item 1A – “Risk Factors” in this Form 10-Q.

 

Key Financial Metrics in Our Business

 

In assessing our performance, we consider a variety of performance and financial measures. The key measures are as follows:

 

Net sales

 

Our net sales are comprised of gross sales net of discounts, in-house coupons and returns and allowances. In comparing net sales between periods we monitor the following:

 

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Change in comparable store sales. We begin to include sales from a store in comparable store sales on the first day of the thirteenth full month following the store’s opening. We monitor the percentage change in comparable store sales by comparing sales from all stores in our comparable store base for a reporting period against sales from the same stores for the same number of operating months in the comparable reporting period of the prior year. When a store that is included in comparable store sales is remodeled or relocated, we continue to consider sales from that store to be comparable store sales. Our comparable store sales data may not be presented on the same basis as our competitors. We use the term “new stores” to refer to stores that have been open for less than thirteen months.

 

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Change in daily average comparable store sales. Daily average comparable store sales are comparable store sales divided by the number of selling days in each period. We use this metric to remove the effect of differences in the number of selling days we are open during the comparable periods (for example, as a result of leap years or the Easter holiday shift between quarters).

 

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Change in mature store sales. We begin to include sales from a store in mature store sales after the store has been open for any part of five fiscal years (for example, our mature stores for fiscal year 2018 are stores that opened during or before fiscal year 2013). We monitor the percentage change in mature store sales by comparing sales from all stores in our mature store base for a reporting period against sales from the same stores for the same number of operating months in the comparable reporting period of the prior year. When a store that is included in mature store sales is remodeled or relocated, we continue to consider sales from that store to be mature store sales. Our mature store sales data may not be presented on the same basis as our competitors.

 

 

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Change in daily average mature store sales. Daily average mature store sales are mature store sales divided by the number of selling days in each period. We use this metric to remove the effect of differences in the number of selling days during the comparable periods (for example, as a result of leap years or the Easter holiday shift between quarters).

 

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Transaction count. Transaction count represents the number of transactions reported at our stores during the period and includes transactions that are voided, return transactions and exchange transactions.

 

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Average transaction size. Average transaction size, or basket size, is calculated by dividing net sales by transaction count for a given time period. We use this metric to track the trends in average dollars spent in our stores per customer transaction.

 

Cost of goods sold and occupancy costs

 

Our cost of goods sold and occupancy costs include the cost of inventory sold during the period (net of discounts and allowances), shipping and handling costs, distribution and supply chain costs (including the costs of our bulk food repackaging facility), buying costs, shrink expense and store occupancy costs. Store occupancy costs include rent, common area maintenance and real estate taxes. Depreciation expense included in cost of goods sold relates to depreciation of assets directly used at our bulk food repackaging facility. The components of our cost of goods sold and occupancy costs may not be identical to those of our competitors, and as a result, our cost of goods sold and occupancy costs data included in this Form 10-Q may not be identical to those of our competitors, and may not be comparable to similar data made available by our competitors. Occupancy costs as a percentage of sales typically decrease as new stores mature and increase sales. Rent payments for leases classified as capital and financing lease obligations are not recorded in cost of goods sold and occupancy costs. Rather, these rent payments are recognized as a reduction of the related obligations and as interest expense. Additionally, depreciation expense related to the capitalized asset is recorded in store expenses.

 

Gross profit and gross margin

 

Gross profit is equal to our net sales less our cost of goods sold and occupancy costs. Gross margin is gross profit as a percentage of net sales. Gross margin is impacted by changes in retail prices, product costs, occupancy costs and the mix of products sold, as well as the rate at which we open new stores.

 

Store expenses

 

Store expenses consist of store level expenses, such as salary and benefits, share-based compensation, supplies, utilities, depreciation, advertising, bank credit card charges and other related costs associated with operations and purchasing support. Depreciation expense included in store expenses relates to depreciation for assets directly used at the stores, including depreciation on capitalized real estate leases, land improvements, leasehold improvements, fixtures and equipment and computer hardware and software. Additionally, store expenses include any gain or loss recorded on the disposal of fixed assets, primarily related to store relocations. The majority of store expenses consist of labor-related expenses, which we closely manage and which trend closely with sales. Labor-related expenses as a percentage of sales tend to be higher at new stores compared to comparable stores, as new stores require a certain level of staffing in order to maintain adequate levels of customer service combined with lower sales. As new stores increase their sales, labor-related expenses as a percentage of sales typically decrease.

 

Administrative expenses

 

Administrative expenses consist of home office-related expenses, such as salary and benefits, share-based compensation, office supplies, hardware and software expenses, depreciation and amortization expense, occupancy costs (including rent, common area maintenance, real estate taxes and utilities), professional services expenses, expenses associated with being a public company, and other general and administrative expenses. Depreciation expense included in administrative expenses relates to depreciation for assets directly used at the home office including depreciation on land improvements, leasehold improvements, fixtures and equipment and computer hardware and software.

 

Pre-opening and relocation expenses

 

Pre-opening and relocation expenses may include rent expense, salaries, advertising, supplies and other miscellaneous costs incurred prior to the store opening. Rent expense is generally incurred from one to four months prior to a store’s opening date for store leases classified as operating. For store leases classified as capital or financing leases, no pre-opening rent expense is recognized. Other pre-opening and relocation expenses are generally incurred in the 60 days prior to the store opening. Certain advertising and promotional costs associated with opening a new store may be incurred both before and after the store opens. All pre-opening and relocation costs are expensed as incurred.

 

 

Operating income

 

Operating income consists of gross profit less store expenses, administrative expenses and pre-opening and relocation expenses. Operating income can be impacted by a number of factors, including the timing of new store openings and store relocations, whether or not a store lease is classified as an operating, capital or financing lease, as well as fluctuations in store expenses and administrative expenses. The amount of time it takes for new stores to become profitable can vary depending on a number of factors, including location, competition, a new market versus an existing market and the strength of store management.

 

Interest expense

 

Interest expense consists of the interest associated with capital and financing lease obligations and interest we incur on outstanding indebtedness, including under our Credit Facility, all net of capitalized interest.

 

Results of Operations 

 

The following table presents key components of our results of operations expressed as a percentage of net sales for the periods presented:

 

		Three months ended December 31,
		2017				2016
Statements of Income Data:*
Net sales			100.0	%			100.0
Cost of goods sold and occupancy costs			73.7				71.6
Gross profit			26.3				28.4
Store expenses			22.3				22.8
Administrative expenses			2.6				2.7
Pre-opening and relocation expenses			0.3				0.7
Operating income			1.1				2.3
Interest expense			(0.5	)			(0.5	)
Income before income taxes			0.5				1.7
Benefit from (provision for) income taxes			2.0				(0.6	)
Net income			2.6	%			1.1
__________________________
*Figures may not sum due to rounding.
Number of stores at end of period			142				131
Number of stores opened during the period			2				5
Total store unit count increase period over period			8.4	%			22.4
Change in comparable store sales			4.7				(0.6	)
Change in daily average comparable store sales			4.7				(0.6	)
Change in mature store sales			1.6				(2.3	)
Change in daily average mature store sales			1.6				(2.3	)

 

 

Three months ended December 31, 2017 compared to the three months ended December 31, 2016

 

The following table summarizes our results of operations and other operating data for the periods presented, dollars in thousands:

 

		Three months ended December 31,								Change In
		2017				2016				Dollars				Percent
Statements of Income Data:
Net sales		$	202,480				183,577				18,903				10.3	%
Cost of goods sold and occupancy costs			149,321				131,424				17,897				13.6
Gross profit			53,159				52,153				1,006				1.9
Store expenses			45,166				41,843				3,323				7.9
Administrative expenses			5,257				4,883				374				7.6
Pre-opening and relocation expenses			543				1,261				(718	)			(56.9	)
Operating income			2,193				4,166				(1,973	)			(47.4	)
Interest expense			(1,089	)			(983	)			(106	)			10.8
Income before income taxes			1,104				3,183				(2,079	)			(65.3	)
Benefit from (provision for) income taxes			4,077				(1,122	)			5,199				(463.4	)
Net income		$	5,181				2,061				3,120				151.4

 

Net sales

 

Net sales increased $18.9 million, or 10.3%, to $202.5 million for the three months ended December 31, 2017 compared to $183.6 million for the three months ended December 31, 2016, due to a $10.3 million increase in sales from new stores and a $8.6 million increase in comparable store sales. Daily average comparable store sales increased 4.7% for the three months ended December 31, 2017 compared to the three months ended December 31, 2016. The daily average comparable store sales increase resulted from a 4.8% increase in daily average transaction count offset by a 0.1% decrease in average transaction size. Comparable store average transaction size was $35.54 for the three months ended December 31, 2017. Daily average mature store sales increased 1.6% for the three months ended December 31, 2017 compared to the three months ended December 31, 2016. The increase in comparable store sales during the three months ended December 31, 2017 was primarily driven by several marketing initiatives and promotional pricing campaigns. In addition, we believe the increase in comparable store sales during the three months ended December 31, 2017 reflected enhanced focus on leadership, training, and improved operating processes in our stores.

 

Gross profit

 

Gross profit increased $1.0 million, or 1.9%, to $53.2 million for the three months ended December 31, 2017 compared to $52.2 million for the three months ended December 31, 2016, primarily driven by an increase in the number of comparable stores. Gross margin decreased to 26.3% for the three months ended December 31, 2017 from 28.4% for the three months ended December 31, 2016. Product margin as a percentage of sales during the three months ended December 31, 2017 decreased due to our promotional pricing campaigns and a shift in sales mix to lower margin products. Additionally, gross margin during the three months ended December 31, 2017 was negatively impacted by an increase in occupancy costs as a percentage of sales, primarily due to the higher average lease expenses experienced at newer format stores opened since fiscal year 2013 and at relocated stores.

 

We had 18 and 16 store leases that were classified as capital and financing lease obligations for the three months ended December 31, 2017 and 2016, respectively. If these leases had qualified as operating leases, the straight-line rent expense would have been included in occupancy costs, and our costs of goods sold and occupancy costs as a percentage of sales during the three months ended December 31, 2017 and 2016, would have been approximately 55 basis points higher for each period.

 

Store expenses

 

Store expenses increased $3.3 million, or 7.9%, to $45.2 million for the three months ended December 31, 2017 compared to $41.8 million for the three months ended December 31, 2016. Store expenses as a percentage of sales were 22.3% and 22.8% for the three months ended December 31, 2017 and 2016, respectively. The decrease in store expenses as a percentage of sales was primarily due to decreases in labor-related expenses, marketing and depreciation, offset by an increase in utilities.

 

Administrative expenses

 

Administrative expenses increased $0.4 million, or 7.6%, to $5.3 million for the three months ended December 31, 2017 compared to $4.9 million for the three months ended December 31, 2016. The increase in administrative expenses was due primarily to increased compensation expenses. Administrative expenses as a percentage of sales were 2.6% and 2.7% for the three months ended December 31, 2017 and 2016, respectively.

 

 

Pre-opening and relocation expenses

 

Pre-opening and relocation expenses decreased $0.7 million, or 56.9%, for the three months ended December 31, 2017 to $0.5 million compared to $1.3 million for the three months ended December 31, 2016, due to the impact of the number and timing of new store openings and relocations. We opened two new stores and relocated one store during the three months ended December 31, 2017 and opened five new stores and relocated no stores during the three months ended December 31, 2016.

 

Interest expense

 

Interest expense, net of capitalized interest, increased $0.1 million, or 10.8%, for the three months ended December 31, 2017 compared to the three months ended December 31, 2016. The increase in interest expense is primarily due to higher average borrowings under our Credit Facility and an increase in the number of capital leases during the three months ended December 31, 2017. If the capital and financing lease obligations had qualified as operating leases, interest expense as a percent of sales would have been approximately 45 and 40 basis points lower than as reported for the three months ended December 31, 2017 and 2016, respectively.

 

Income taxes 

 

Income taxes decreased $5.2 million for the three months ended December 31, 2017 to a $4.1 million benefit compared to $1.1 million expense for the three months ended December 31, 2016. Exclusive of the adjustment to deferred income tax assets and liabilities, the Company’s effective income tax rate for the three months ended December 31, 2017 was approximately 23.5% as compared to 35.2% for the three months ended December 31, 2016. The decrease in the effective income tax rate for the three months ended December 31, 2017 is a result of the recent tax reform.

 

Net income

 

Net income was $5.2 million, or $0.23 diluted earnings per share, for the three months ended December 31, 2017 compared to $2.1 million, or $0.09 diluted earnings per share, for the three months ended December 31, 2016. Excluding the favorable impact of the remeasurement of our deferred tax assets and liabilities as a result of the enactment of the Tax Reform Act, net income was $0.8 million or $0.04 diluted earnings per share for the three months ended December 31, 2017 compared to $2.1 million, or $0.09 diluted earnings per share, for the three months ended December 31, 2016.

 

Non-GAAP financial measures

 

EBITDA

 

EBITDA is not a measure of financial performance under GAAP. We define EBITDA as net income before interest expense, provision for income taxes and depreciation and amortization. The following table reconciles net income to EBITDA for the periods presented, dollars in thousands:

 

		Three months ended December 31,
		2017				2016
Net income		$	5,181				2,061
Interest expense			1,089				983
Benefit from (provision for) income taxes			(4,077	)			1,122
Depreciation and amortization			7,415				7,121
EBITDA		$	9,608				11,287

 

EBITDA decreased 14.9% to $9.6 million in the three months ended December 31, 2017 compared to $11.3 million for the three months ended December 31, 2016. EBITDA as a percentage of sales was 4.7% and 6.1% in the three months ended December 31, 2017 and 2016, respectively. Stores with leases that are classified as capital and financing lease obligations, rather than being reflected as operating leases, increased EBITDA as a percentage of sales by approximately 55 basis points for each of the three months ended December 31, 2017 and 2016, due to the impact on cost of goods sold and occupancy costs as discussed above, as well as occupancy costs that would have been included in pre-opening expenses prior to the stores’ opening dates if these leases had been accounted for as operating leases.

 

 

Management believes that some investors’ understanding of our performance is enhanced by including EBITDA, a non-GAAP financial measure. We believe EBITDA provides additional information about: (i) our operating performance, because it assists us in comparing the operating performance of our stores on a consistent basis, as it removes the impact of non-cash depreciation and amortization expense as well as items not directly resulting from our core operations such as interest expense and income taxes and (ii) our performance and the effectiveness of our operational strategies. Additionally, EBITDA is a component of a measure in our financial covenants under our Credit Facility. Further, our incentive compensation plan bases incentive compensation payments on EBITDA, among other measures.

 

Furthermore, management believes some investors use EBITDA as a supplemental measure to evaluate the overall operating performance of companies in our industry. Management believes that some investors’ understanding of our performance is enhanced by including this non-GAAP financial measure as a reasonable basis for comparing our ongoing results of operations. By providing this non-GAAP financial measure, together with a reconciliation from net income, we believe we are enhancing analysts’ and investors’ understanding of our business and our results of operations, as well as assisting analysts and investors in evaluating how well we are executing our strategic initiatives.

 

Our competitors may define EBITDA differently, and as a result, our measure of EBITDA may not be directly comparable to those of other companies. Items excluded from EBITDA are significant components in understanding and assessing financial performance. EBITDA is a supplemental measure of operating performance that does not represent, and should not be considered in isolation or as an alternative to, or substitute for, net income or other financial statement data presented in the consolidated financial statements as indicators of financial performance. EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as an alternative to, or as a substitute for, analysis of our results as reported under GAAP. Some of the limitations are:

 

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EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

 

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EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

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EBITDA does not reflect any impact for straight-line rent expense for leases classified as capital and financing lease obligations;

 

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EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

 

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EBITDA does not reflect our tax expense or the cash requirements to pay our taxes; and

 

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although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and EBITDA does not reflect any cash requirements for such replacements.

 

Due to these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA as supplemental information.

 

Liquidity and Capital Resources

 

Our ongoing primary sources of liquidity are cash generated from operations, current balances of cash and cash equivalents and borrowings under the Credit Facility. Our primary uses of cash are for purchases of inventory, operating expenses, capital expenditures predominantly in connection with opening, relocating and remodeling stores, interest and principal payments for outstanding indebtedness and corporate taxes. As of December 31, 2017, we had $8.1 million in cash and cash equivalents, as well as $24.4 million available for borrowing under our Credit Facility.

 

On May 5, 2016, our Board authorized a two-year share repurchase program pursuant to which the Company may expend up to $10.0 million to repurchase shares of the Company’s common stock. During the three months ended December 31, 2017, we repurchased 101,573 shares of our common stock under the share repurchase program. We expect funding for any future share repurchases will come from operating cash flow, excess cash and/or borrowings under our Credit Facility. The timing and the amount of shares repurchased will be dictated by our capital needs and stock market conditions.

 

We plan to continue to open new stores, which may require us to borrow additional amounts under the Credit Facility. We plan to spend approximately $20 million to $25 million on capital expenditures during the remainder of fiscal year 2018 in connection with six to eight additional new store openings and two to three additional store relocations. We believe that cash and cash equivalents, together with the cash generated from operations and the borrowing availability under our Credit Facility will be sufficient to meet our working capital needs and planned capital expenditures, including capital expenditures related to new store needs for at least the next twelve months. Our working capital position benefits from the fact that we generally collect cash from sales to customers the same day or, in the case of credit or debit card transactions, within days from the related sale.

 

 

We anticipate that our new stores will require, on average, an upfront capital investment of approximately $2.2 million per store consisting of capital expenditures of approximately $1.6 million, net of tenant allowances, initial inventory of approximately $0.3 million, net of payables, and pre-opening expenses of approximately $0.3 million.

 

Following is a summary of our operating, investing and financing activities for the periods presented, dollars in thousands:

 

		Three months ended December 31,
		2017				2016
Net cash provided by operating activities		$	10,969				14,094
Net cash used in investing activities			(4,884	)			(10,493	)
Net cash used in financing activities			(4,517	)			(476	)
Net increase in cash and cash equivalents			1,568				3,125
Cash and cash equivalents, beginning of period			6,521				4,017
Cash and cash equivalents, end of period		$	8,089				7,142

 

Operating Activities

 

Net cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation and amortization and changes in deferred taxes, and the effect of working capital changes. Cash provided by operating activities decreased $3.1 million, or 22.2%, to $11.0 million for the three months ended December 31, 2017 compared to $14.1 million for the three months ended December 31, 2016. The decrease in cash provided by operating activities was primarily due to a decrease in accounts payable, partially offset by a decrease in inventory, as adjusted for non-cash items such as depreciation and amortization resulting from the addition of new stores. Our working capital requirements for inventory will likely increase as we continue to open new stores.

 

Investing Activities

 

Net cash used in investing activities decreased $5.6 million, or 53.4%, to $4.9 million for the three months ended December 31, 2017 compared to $10.5 million for the three months ended December 31, 2016. This decrease was due to an $8.1 million decrease in cash paid for property and equipment, which was driven by fewer new store openings, relocations and remodels in the quarter ended December 31, 2017. This decrease was partially offset by $2.6 million proceeds, net of commissions, related to the sale/leaseback on one store building in the quarter ended December 31, 2016.

 

Financing Activities

 

Cash used in financing activities consists primarily of borrowings and repayments under our Credit Facility and payments of capital and financing lease obligations. Cash used in financing activities was $4.5 million and $0.5 million for the three months ended December 31, 2017 and 2016, respectively.

 

Credit Facility

 

The amount available for borrowing under the Credit Facility is $50.0 million, including a $5.0 million sublimit for standby letters of credit. The operating company is the borrower under the Credit Facility and its obligations under the Credit Facility are guaranteed by the holding company and VC2. The Credit Facility is secured by a lien on substantially all of the Company’s assets. The Company has the right to borrow, prepay and re-borrow amounts under the Credit Facility at any time prior to the maturity date. The Credit Facility matures on January 31, 2021.

 

For floating rate borrowings under the Credit Facility, interest is determined by the lender’s administrative agent based on the most recent compliance certificate of the operating company and stated at the base rate less the lender spread based upon certain financial measures. For fixed rate borrowings under the Credit Facility, interest is determined by quoted LIBOR rates for the interest period plus the lender spread based upon certain financial measures. The unused commitment fee is based upon certain financial measures.

 

The Credit Facility requires compliance with certain customary operational and financial covenants, including a leverage ratio. The Credit Facility also contains certain other customary limitations on the Company’s ability to incur additional debt, guarantee other obligations, grant liens on assets and make investments or acquisitions, among other limitations. Additionally, the Credit Facility prohibits the payment of cash dividends, except that so long as no default exists or would arise as a result thereof, the operating company may pay cash dividends to the holding company for various audit, accounting, tax, securities, indemnification, reimbursement, insurance and other reasonable expenses incurred in the ordinary course of business, and for repurchases of shares of common stock in an amount not to exceed $10.0 million.

 

 

We had $24.6 million outstanding under the Credit Facility as of December 31, 2017 and $28.4 million outstanding under the Credit Facility as of September 30, 2017. As of each of December 31, 2017 and September 30, 2017, we had undrawn, issued and outstanding letters of credit of $1.0 million, which were reserved against the amount available for borrowing under the terms of the Credit Facility. We had $24.4 million available for borrowing under the Credit Facility as of December 31, 2017 and $20.6 million available for borrowing under the Credit Facility as of September 30, 2017.

 

As of December 31, 2017 and September 30, 2017, the Company was in compliance with the financial covenants under the Credit Facility.

 

Share Repurchases

 

Certain information about the Company's share repurchases is set forth under the heading "Share Repurchases" in Note 5 of Notes to Unaudited Interim Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q and in Part II, Item 2 of this Form 10-Q.

 

Off-Balance Sheet Arrangements 

 

As of December 31, 2017, our off-balance sheet arrangements consisted of operating leases and the undrawn portion of our Credit Facility. All of our stores and facilities, with one exception, are leased. We own buildings in which five of our stores are located; those buildings are located on land that is leased pursuant to a ground lease. As of December 31, 2017, 18 store leases were classified as capital and financing lease obligations, and the remaining leases were classified as operating leases in our consolidated financial statements. We have no other off-balance sheet arrangements that have had, or are reasonably likely to have, a material effect on our consolidated financial statements or financial condition.

 

Recent Accounting Pronouncements

 

See Note 2 to the consolidated financial statements included in this Form 10-Q.

 

Critical Accounting Policies

 

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. Actual amounts may differ from these estimates. We base our estimates on historical experience and on various other assumptions and factors that we believe to be reasonable under the circumstances. We evaluate our accounting policies and resulting estimates on an ongoing basis to make adjustments we consider appropriate under the facts and circumstances. 

 

Critical accounting policies that affect our more significant judgments and estimates used in the preparation of our financial statements include accounting for income taxes, accounting for impairment of long-lived assets and accounting for leases, which are discussed in more detail under the caption “Critical Accounting Policies” under Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Form 10-K.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

To a limited extent, we are exposed to interest rate changes with respect to our Credit Facility. We do not use financial instruments for trading or other speculative purposes. There have been no material changes regarding our market risk position from the information provided under Item 7A - “Quantitative and Qualitative Disclosures about Market Risk” in our Form 10-K.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our principal executive officers and principal financial and accounting officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act, as of the end of the period covered by this Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

 

Based on that evaluation, our principal executive officers and principal financial and accounting officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of December 31, 2017.

 

Changes in Internal Control over Financial Reporting

 

Management implemented additional internal controls over financial reporting to ensure compliance with the Tax Reform Act. There were no other changes in our internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. Other Information

 

Item 1. Legal Proceedings

 

We periodically are involved in various legal proceedings, including discrimination and other employment-related claims, customer personal injury claims, investigations and other proceedings arising in the ordinary course of business. When the potential liability from a matter can be estimated and the loss is considered probable, we record the estimated loss. Due to uncertainties related to the resolution of lawsuits, investigations and claims, the ultimate outcome may differ from our estimates. Although we cannot predict with certainty the ultimate resolution of any lawsuits, investigations and claims asserted against us, we do not believe any currently pending legal proceeding to which we are a party will have a material adverse effect on our business, prospects, financial condition, cash flows or results of operations.

 

Item 1A. Risk Factors

 

There have been no material changes from the risk factors disclosed in Part I, “Item 1A-Risk Factors,” of our Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table presents information with respect to purchases of the Company’s common stock during the three months ended December 31, 2017 by the Company or any affiliated purchaser, as defined in Rule 10b-18(a)(3) under the Exchange Act.

 

Period		Total Number of Shares Purchased				Average Price Paid Per Share(1)				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2)				Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in thousands)
October 1, 2017 to October 31, 2017			87,950				$5.69				185,920				$8,410
November 1, 2017 to November 30, 2017			13,623				5.91				199,543				8,329
December 1, 2017 to December 31, 2017			—				—				199,543				8,329
Total			101,573				$5.72				199,543				$8,329

 

 

⁽¹⁾     Average price paid per share includes commissions paid.

 

⁽²⁾     On May 5, 2016, our Board authorized a two-year share repurchase program pursuant to which the Company may repurchase up to $10.0 million in shares of the Company’s common stock.

 

 

Item 6. Exhibits

 

EXHIBIT INDEX

 

Exhibit Number		Description
10.46		Employment offer letter to Todd Dissinger dated December 5, 2017
10.47		Notice of Grant of Stock Unit Award to Todd Dissinger dated January 2, 2018
31.1		Certification of Kemper Isely, a Principal Executive Officer Required Under Section 302(a) of the Sarbanes-Oxley Act of 2002
31.2		Certification of Zephyr Isely, a Principal Executive Officer Required Under Section 302(a) of the Sarbanes-Oxley Act of 2002
31.3		Certification of Todd Dissinger, Principal Financial Officer Required Under Section 302(a) of the Sarbanes-Oxley Act of 2002
32.1†		Certification of Principal Executive Officers and Principal Financial Officer Required Under 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		The following materials from Natural Grocers by Vitamin Cottage, Inc.’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of December 31, 2017 (unaudited) and September 30, 2017, (ii) Consolidated Statements of Income for the three months ended December 31, 2017 and 2016 (unaudited), (iii) Consolidated Statements of Cash Flows for the three months ended December 31, 2017 and 2016 (unaudited) and (iv) Notes to Unaudited Interim Consolidated Financial Statements.

 

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† The certifications attached as Exhibit 32.1 that accompany this Form 10-Q are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Natural Grocers by Vitamin Cottage, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized on February 1, 2018.

 

 

	Natural Grocers by Vitamin Cottage, Inc.
	By:	/s/ KEMPER ISELY
		Kemper Isely, Co-President
		(Principal Executive Officer)
	By:	/s/ TODD DISSINGER
		Todd Dissinger, Chief Financial Officer
		(Principal Financial and Accounting Officer)

 

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